Friday, June 6, 2014

Colin Rogers’ Money, Interest and Capital, Chapter 1

Colin Rogers’ Money, Interest and Capital: A Study in the Foundations of Monetary Theory (Cambridge, 1989) is a Post Keynesian study of monetary theory and a critique of neoclassical monetary and interest rate theory.

A quick summary of Chapter 1 follows in this post.

Rogers notes that the post-WWII neoclassical synthesis attempted to reconcile the theories of Wicksell and Walras with Keynes’ General Theory, but the result was either incoherent Wicksellian theory or a Walrasian theory that does not have a proper role for money (Rogers 1989: xvii).

In essence, modern neoclassical monetary theory is divided into two strands, as follows:

(1) Wicksellian/neo-Wicksellian general equilibrium theory, and

(2) neo-Walrasian general equilibrium theory.

The Wicksellian/neo-Wicksellian general equilibrium theory is subject to devastating problems through the Cambridge Capital critique, for Wicksell’s capital theory is the basis of his idea of the natural rate of interest, and once Wicksell’s capital theory is exploded, his natural rate of interest concept is also destroyed (Rogers 1989: 5).

Since the natural rate of interest is also the fundamental basis of classical loanable funds theory, the latter too must fall (Rogers 1989: 5), a point missed by economists who have interpreted Keynes’ work like Kohn (1986) and Leijonhufvud (1981).

Rogers (1989: 5) contends that neo-Walrasian models do not use the Wicksellian concept of capital, but are utterly flawed by the way they assume money away and effectively reduce to models of perfect barter (Rogers 1989: 5).

Various strands of neoclassical theory (even the neoclassical Keynesian tradition) draw on either the Wicksellian or neo-Walrasian traditions but both are equally flawed.

Neoclassical monetary theory, in all forms, is real analysis because non-monetary factors are what determine long-period equilibrium positions and money is reduced to a neutral veil in the long run (Rogers 1989: 4), and even if monetarists and neoclassical Keynesians are willing to recognise the short-run non-neutrality of money, they remain fixated on the unrealistic long-run implications of their general equilibrium models (Rogers 1989: 7).

Moreover, even credit money – the predominant form of money in modern economies – is reduced to having the same properties as commodity money in general equilibrium models (Rogers 1989: 4). This is a serious mistake, for credit is not a commodity and the Wicksellian natural rate of interest is worthless, except as a purely logical concept in an empirically irrelevant abstract model with one commodity (Rogers 1989: 10).

A genuine monetary theory, by contrast, sees money as fundamentally non-neutral, and real and monetary forces will determine any long period equilibrium positions (Rogers 1989: 4, 8).

The key is that the money rate of interest in a modern economy with credit money cannot be usefully explained by means of either classical or neoclassical theory (Rogers 1989: 9), and must be seen as an exogenous variable (Rogers 1989: 12).

Rogers (1989: 10–11) adopts Marshallian partial equilibrium analysis and what he calls a “monetary equilibrium” approach which describes the relationship between the rate of interest and the marginal efficiencies of all assets: in short, a “monetary equilibrium” is equality between the rate of interest and the marginal efficiency of capital (Rogers 1989: 11).

In this model, the long-term money rate of interest sets the rate of return to which other marginal efficiencies adjust in the long run, and the money rate of interest plays a significant role in the production of capital goods, and hence on aggregate investment and the level of employment (Rogers 1989: 12). Since in the market economy, there is no mechanism that will adjust the exogenous rate of interest to the right investment level to create effective demand and full employment, the rate of interest must be determined by government monetary policy (Rogers 1989: 13).

Rogers’ model is dependent on Keynes’ General Theory and Kregel (1983), but differs from other Post Keynesian models, and assumes an initial static equilibrium model in which short and long period expectations are realised (Rogers 1989: 14).

But one should note the problems even with Keynes’ analytical model – and by implication with Rogers’ own – that some Post Keynesians have identified:

(1) the marginal efficiency of capital (MEC) idea. Keynes, in developing the MEC, failed to free himself from the neoclassical marginal productivity of capital (King 2002: 209). As Joan Robinson notes,

“[sc. Keynes] made a fatal mistake in offering a quasi-long-period definition of the inducement to invest as the ‘marginal efficiency of capital’, that is, the profit that will be realised on the increment to the stock of capital that results from current investment and, still worse, identified the profitability of capital with its social utility. This was an element in the old doctrine from which he failed to escape. He had an alternative concept of the inducement to invest as the expected future return on sums of finance to be devoted to investment. Minsky (1976) points out that he did not seem to recognise the difference between the two formulations. If he had stuck to his short-period brief, he would have used only the second.” (Robinson 1979: 179–180).

The MEC seems to suggest that there exists a rate of interest which is low enough to induce full utilization of capital goods. But this is just smuggling in the Wicksellian natural rate of interest, when Keynes had wanted to abandon the natural rate.

A number of Post Keynesians reject the MEC, because it is based on the neoclassical or marginalist theory of distribution.

(2) Keynes did not sufficiently stress the role of uncertainty and expectations in undermining the coordinating role of interest rates (King 2002: 14). In Chapter 18 of the General Theory, Keynes played down the role of uncertainty (which he had stressed in Chapter 12) and, if he had really maintained the crucial role of uncertainty as he did later in Keynes (1937), this would have “ruled out any stable functional relationship between investment and the interest rate” (King 2002: 14). The door was thereby left open for neoclassical synthesis Keynesians to reformulate the General Theory as a general equilibrium model where the interest rate has a pivotal role (King 2002: 14).

It seems to me that one must read Rogers’ Money, Interest and Capital with these caveats in mind too.

17 comments:

Boy Oh Boy,Where do I begin?First, what exactly did the Cambridge Capital Controversies accomplish? Paul Krugman, (!) not exactly a beacon of free market conservatism and libertarian thought, says "And what’s going on here, I think, is a fairly desperate attempt to claim that the Great Recession and its aftermath somehow prove that Joan Robinson and Nicholas Kaldor were right in the Cambridge controversies of the 1960s. It’s a huge non sequitur, even if you think they were indeed right (WHICH YOU SHOULDN"T {Emphasis mine}) But that’s what seems to be happening." http://krugman.blogs.nytimes.com/2014/05/01/hangups-of-the-heterodox-vaguely-wonkish/?_php=true&_type=blogs&_r=0

Second, explain the "Fisher effect" of rising interest rates all across the economy in periods of high inflation and ngdp growth if money isn't long run neutral . I'm not talking about central bank responses to control inflation by raising "benchmark" interest rates, even when the prime rate was lowered, in high inflation decades such as the seventies, rates all across the economy stayed extremely high (And no Philip Pilkington, this has nothing whatsoever to do with fixed exchange rates- the U.S. went off the gold window and fixed forex in 1971, and interest rates remained extremely high. (By the way there were two separate oil shocks, 1973-1974, and one in 1979, in between those periods, the negative supply shock had temporarily ended, yet inflation remained high. This was demand pull, not cost-push, ngdp growth was also exorbitant in the 1970s)

Going back to the Cambridge Capital Controversies for a moment, what exactly where they supposed to prove? That you can't add distinct forms of capital together, even their monetary values to get at the wildly and weirdly misnamed absurd "rate of profit" But you can! You can say that aggregate demand regulates the rate of RETURN (I refuse to use that ridiculous Marxian expression) across the whole economy and all capital goods sectors, and the MPC describes a singular class of capital.(Discounting its net present value, purchase price, and the risk free rate, etc) What exactly, is the problem here?

The notion of the neutrality of money in either the short and/or long run is an utter absurdity.

It would require perfect adjustment of all quantities expressed in money units --- prices, wages, debt contracts, and in fact all nominal contracts of any type in money terms -- instantly or nearly instantly in response to changing conditions.

It would furthermore require the abolition of uncertainty and the shifting types of liquidity preference that characterise capitalist economies, and, above all, the holding of money as a hedge against future uncertainty.

"I'm not talking about central bank responses to control inflation by raising "benchmark" interest rates, even when the prime rate was lowered, in high inflation decades such as the seventies, rates all across the economy stayed extremely high."

Empirically wrong. Interest rates followed overnight rate. Duh.

http://research.stlouisfed.org/fred2/graph/fredgraph.png?g=CNe

I also like the appeal to authority in the form of Krugman. Very amusing.

"It would require perfect adjustment of all quantities expressed in money units --- prices, wages, debt contracts, and in fact all nominal contracts of any type in money terms -- instantly or nearly instantly in response to changing conditions."

It would require nothing of the sort. "Instantly or nearly instantly, do you seriously not understand the difference between the short and the long run? Debt can be defaulted on and contracts renegotiated.

"It would furthermore require the abolition of uncertainty and the shifting types of liquidity preference that characterise capitalist economies, and, above all, the holding of money as a hedge against future uncertainty."

It speaks to my common sense. And I noticed you didn't address the Fisher effect during the seventies because you can't. It doesn't fit your absurd model.

One more caveat: Expectations are never neutral. A sadistic government that constantly subjects the private market to exogenous shocks in an unpredictable manner can stretch the short run into a very, very, long run. But in this case the problem isn't money. its the incompetence and tyranny of government. When expectations are stable money is long run neutral.

(2) on the Fisher effect, the fact that nominal interest rates might be adjusted in anticipation of inflation changes hardly proves that money is neutral in the long run. For one thing, we live in a world of uncertainty, and people's expectations may be wrong -- sometimes badly wrong.

Secondly, neutral money would require much more than mere adjustment of nominal interest rates in relation to inflation. E.g., if asset prices, prices and wages collapse, then the principals of nominal debts would have to adjusted too.

If you think all or even most nominal debts really are regularly adjusted like this in the real world, you may as well live in Narnia and spend your time dancing with centaurs.

I don't believe in long-run money neutrality either. However, the reasons you are giving here are ones that I normally associate with the question of short-run neutrality. Doesn't the long run mean enough time for nominal debt adjustments to have taken place?

Are we talking about some imaginary "long run" where money is neutral by definition, or a long term period of time in the real world?

All nominal debts contracts are not automatically adjusted to reflect other values in the real world, even in the long run. Do you really think nominal debts even in the long run are, for example, carefully and automatically adjusted for inflation?

It is not true. In the real world, it is the case that debtors with long tern debts often do benefit from inflation as it erodes the real value of their principal and interest payments.

I think the existence of nominal debt contracts is a very convincing argument why money cannot be neutral in the short run, even with completely flexible prices. I have argued that myself several times, although I think most money neutrality advocates accept this point even if they often ignore it.

The idea here is that nominal flow quantities could in theory adjust very quickly if prices were flexible, but nominal stock quantities cannot. Changing nominal stock quantities generally has to involve flows taking place over a period of time. This can have very significant real effects. Nevertheless, money neutrality advocates would argue that the real equilibrium value of those stocks is independent of the price level so that, in time, money neutrality must reassert itself. This is the usual argument I face.

A few points. First, as you point out, there is the question of how long we are talking about. If it is going to take 500 years for money neutrality to work, then we can effectively forget about it. Would it take that long? Actually, I don't know and I haven't seen anyone argue convincingly either way.

More fundamentally, the argument for long run neutrality relies on the idea that there is a long term real equilibrium. Even if you believe in equilibria, there are problems here. We are never actually at a long run equilibrium; we are only ever moving towards one and the target is moving. There is also no general reason to believe there are not multiple equilibria, so given the short run real effects we could quite easily end up moving towards a different long run equilibrium. One short run impact of money non-neutrality is a redistributive effect. As people are not all identical in their actions and preferences, this will also affect any long run equilibrium. Furthermore, many things like technology and productivity may well be path dependent, so short run effects can turn out to be permanent. I'm sure there are many more reasons.

I do generally consider myself to be a post-Keynesian, but I am keen not to be confined by a label. I decide for myself what to believe and what not, and that's not always the post-Keynesian view.

"The ordinary theory of distribution, where it is assumed that capital is getting now its marginal productivity (in some sense or other), is only valid in a stationary state. The aggregate current return to capital has no direct relationship to its marginal efficiency; whilst its current return at the margin of production (i.e. the return to capital which enters into the supply price of output) is its marginal user cost, which also has no close connection with its marginal efficiency."

"on the Fisher effect, the fact that nominal interest rates might be adjusted in anticipation of inflation changes hardly proves that money is neutral in the long run."

Yes, you see it does. The Fisher effect states that the nominal interest rate equals the real rate plus inflation. Unemployment would not have skyrocketed in the 70's if there were a permanent inflation employment tradeoff.

"For one thing, we live in a world of uncertainty, and people's expectations may be wrong -- sometimes badly wrong."

True, but once errors are exposed, prices revert to their true values. Markets reveal their own errors more swiftly than governments.In the U.S. in 2007 late in the year, markets saw the subprime crisis' severity before government did, and the bailout of Bear hardly reassured them.

"Secondly, neutral money would require much more than mere adjustment of nominal interest rates in relation to inflation. E.g., if asset prices, prices and wages collapse, then the principals of nominal debts would have to adjusted too."

Not necessarily. (Again, long vs short run.)

"If you think all or even most nominal debts really are regularly adjusted like this in the real world, you may as well live in Narnia and spend your time dancing with centaurs."

Don't mistake me for an RBC theorist. (Nor an Austrian) i don't deny that this can take a long time, Nor do I deny that this can be incredibly painful.(Which in part depends on how friendly bankruptcy laws are to debtors) This is why I prefer stimulus than letting markets clear on their own.

But saying the clearing process is incredibly painful is different than saying it doesn't happen entirely

LK, on point (1) he is talking about some form of the EMH. He is not being clear on this because he is not clear about the arguments in his own mind. But remember my argument that the natural rate of interest is dependent on the EMH? That is what is going on here. He is trying to put forward a theory of "neutral" financial markets that, in the long-run, balance savings and investment at a full employment equilibrium. Nonsense, of course. And the fact that some "economists" are still making this case as the dotcom bubble and the housing bubble burst within a decade of one another says how freely these guys float away from the real world. I don't bother engaging with these guys any more. They're fossils. The behaviorists have moved the mainstream quite a way away from them.

Philip Pilkington,""I'm not talking about central bank responses to control inflation by raising "benchmark" interest rates, even when the prime rate was lowered, in high inflation decades such as the seventies, rates all across the economy stayed extremely high."

Empirically wrong. Interest rates followed overnight rate. Duh.

http://research.stlouisfed.org/fred2/graph/fredgraph.png?g=CNe

What are YOU talking about? There are several points on your graph where the Moody Corporate Bond yield and the 30 year conventional mortgage rate diverge from the fed funds rate: namely in 1971, 1976 and 1982 (all after recessions)

""And no Philip Pilkington, this has nothing whatsoever to do with fixed exchange rates- the U.S. went off the gold window and fixed forex in 1971, and interest rates remained extremely high."

What on earth is this guy talking about? His comment is entirely incoherent…"

You appeared on the blog of the Moneyillusion.com making incoherent arguments with the blog owner on interest rates in hyper inflationary countries with "fixed currencies" You're wrong again

"What are YOU talking about? There are several points on your graph where the Moody Corporate Bond yield and the 30 year conventional mortgage rate diverge from the fed funds rate: namely in 1971, 1976 and 1982 (all after recessions)"

Obviously you do not understand bond markets at all. Interest rates across markets gravitate toward the overnight rate WITH A LAG and SUBJECT TO UNCERTAINTY AS TO WHERE THE OVERNIGHT RATE WILL MOVE IN THE FUTURE. I am not going to explain why this is. If you do not understand the reasons for this then take a course in bonds in a financial economics department or read a good writer on the topic of bond markets. For the purposes of the empirically dubious claim you made earlier it is clear from the data that interest rates across the market are following the overnight rate. This implies that the overnight rate has the most sway on actual yields and thus that the idea that there is some "real" forces moving the market in line with some outdated economic theory is totally false.

As to my arguments on Money Illusion you obviously didn't understand them because you are unable to summarise them. In fact, you appear unable to summarise anything. All your posts come across as someone who has learned a few key words about economic debates but been unable to digest the debates themselves. I think you need to hit the books, pal, both on bond markets and on the debates you hope to intervene in.

Here. Look very closely at the periods you cited and you will see that although the interest rates diverge (who argued that they may not) they are nevertheless CORRELATED which is the important thing for economic argument (take a course in statistics if you don't understand why this is):

http://research.stlouisfed.org/fred2/graph/fredgraph.png?g=CQn

The differences in the strengths of the correlation have to do with the perceptions that exist in the market as to where the Fed is about to move the rate. But there's no way I'm going to get into liquidity preference theory with you before you have even shown yourself capable of reading a correlation or understand how we make causal arguments in economics.